Inflation Moderately Pressures US Public Pension Liabilities
The high inflation environment in the US is likely to have only moderately negative effects on state and local government public pension plan liabilities via automatic cost of living adjustment (COLA) mechanisms but will pressure plans through weakening asset performance and rising payroll costs, Fitch Ratings says. Market value smoothing and supplemental pension contributions by some governments this year from budget surpluses will help partially mitigate these challenges.
While automatic COLA provisions differ across plans, those plans that provide them typically cap inflation-triggered benefit increases at around 2.5%–3.0%, well below recent headline inflation of 8.5%, blunting their effects on plan liabilities. COLA-related inflation concerns would become more pressing if state and local pension sponsors enhance automatic COLAs or otherwise reverse COLA limits adopted after the Great Recession. Such changes could be motivated by real concerns about retirees’ purchasing power or by the need to fill vacant public sector jobs. Raising relatively low COLA caps would weigh most on plans in which the funded status has never fully recovered from the Great Recession.
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